Income tax cuts emerge as key issue in AZ GOP gubernatorial race

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Depending on who wins the Republican primary in the hotly contested governor’s race, Arizona may see some major cuts, even the outright elimination, in income taxes.
Three Republican gubernatorial candidates — Secretary of State Ken Bennett, state Treasurer Doug Ducey and state Sen. Al Melvin — have pledged to phase out corporate and individual income tax rates. None say they would do so immediately, but would strive to eliminate the taxes by the time they leave office. Ducey said he wants to bring income tax rates “as close to zero as possible” with the goal of eliminating them altogether.
The amount of revenue that Arizona gets from income taxes is staggering. The Joint Legislative Budget Committee projects that corporate and individual income taxes will bring in about $4.1 billion in revenue this fiscal year, out of almost $8.9 billion in total state revenue.
Individual income taxes make up the bigger share, accounting for more than $3.4 billion, or 39 percent of the state’s revenue for fiscal year 2014. Corporate incomes taxes are expected to bring in $683 million, accounting for about 8 percent of the state’s revenue this fiscal year.
Corporate income taxes are already scheduled to decrease over the next three years. Under the 2011 Arizona Competitiveness Package, Arizona’s corporate income tax rate of 6.5 percent will drop to 6 percent in fiscal year 2015, 5.5 percent in 2016 and 4.9 percent in 2017.
Arizona’s individual income tax rates range from 2.59 percent for the lowest tax bracket to 4.54 percent for the highest.
Despite widespread conservative support for low taxes, some candidates are criticizing the trio for touting a plan that the critics say is unrealistic and even irresponsible. And several economists say income taxes couldn’t be scrapped without either major budget cuts or increases in other taxes to offset the lost revenue.
But the candidates say they can make it work.
Candidates with a plan
The candidates’ plans all come with caveats. Bennett said he would look to replace lost sales tax revenue with new money from an expanded sales tax and consumption tax base. Ducey said he would like to spur economic growth in order to first create the revenue that would offset the loss of income tax revenue, and said lower taxes would lead to more growth. And Melvin is counting on tax cuts and other policies to dramatically improve Arizona’s economic climate.
At a May 20 candidate forum, Ducey touted his role on a 2012 campaign against a ballot measure that would have made permanent a temporary 1-cent sales tax increase that was about to expire. If elected, he said he’ll pick up where he left off by reducing the income tax rates with a goal of eventually driving them down to zero.
Ducey told the Arizona Capitol Times that he’d like to target both the individual and corporate rates. But fulfilling his goal will take three things — a full term or two as governor, a detailed plan and a growing economy.
Ducey said tax cuts could be contingent on economic growth, and he’ll want to see what kind of shape Arizona’s economy is in before he does anything. But he also emphasized that his goal is to propose tax-cutting legislation for every year of his governorship.
“We’re going to look at where we are in terms of where the economy is, where we are in growth and those types of factors. But either way, we’re going to want to have a lower tax burden on our citizens in the state of Arizona,” Ducey said. “When you grow your economy, when you have more transactions out there, when people are buying more ice cream and other goods, they’re paying more sales tax. And that grows the state’s economy. So you have to look at both sides of the equation.”
On the campaign trail, Bennett often talks of how much business Arizona loses to other states that don’t have an income tax. If those states can do it, he said, so can Arizona.
Bennett, who said early in his campaign that it might be possible to eliminate income taxes by the end of his first year as governor, now said he’s eying a more gradual approach. He said he doesn’t know how long it would take to phase out the corporate and individual income taxes altogether.
But he often says his proposed tax cuts would have to be revenue neutral, meaning the lost income from taxes would be replaced by income from other sources. Bennett speaks on the campaign trail of replacing income taxes with a broad-based consumption tax.
Lost revenue from phased-out income taxes could be replaced by expanding the sales tax base to labor, services and other things, Bennett said. He also said the state would reap additional revenues from the economic growth that the tax cuts would spur.
“It would be revenue neutral, but if the economy expands, the state would have an expansion in resources,” Bennett said. “It could be from both.”
Melvin also indicated that increased economic activity would help pay for the tax cuts, which would be phased in over the course of eight years as governor. He said his proposed tax cuts, along with other policy proposals, such as “Texas-style” tort reform, would lead to a “rush of companies” coming to Arizona.
“I believe that, plus these declared intentions, will bring a tremendous amount of business into the state,” Melvin said.
Each of the candidates said they are opposed to raising taxes.
Not so fast
Some economists are skeptical of the candidates’ plans.
Several Valley economists said there’s no way to replace more than $4 billion in revenue without raising taxes elsewhere, unless the would-be governors are willing to make dramatic cuts in services. Even a major expansion of the sales tax base and other consumption taxes wouldn’t come close to filling the gap, and most say the increased economic activity stemming from the tax cuts wouldn’t do the job either.
Jim Rounds, an economist with Elliott D. Pollack and Company, said there’s simply no way to replace the lost revenue without raising taxes. Rounds said he has no problem with incremental reductions, as long as they’re revenue neutral, at least to start with.
“If they take small steps they can just keep going until the math doesn’t work anymore,” he said.
Rounds said some extra money could be found by expanding the sales tax base or other consumption taxes. But he questioned whether the state could get more than $300 million from such a plan, which would only offset a small reduction in income taxes.
Dennis Hoffman, an economics professor at Arizona State University’s W.P. Carey School of Business, said the state could get more than that, but still nowhere near the billions of dollars the state would lose by eliminating income taxes.
“It depends on how broad you want to make it. You could probably find your way to a billion. And I’m not saying it would be easy, but I could say your way to a billion,” Hoffman said. “But finding three and a half would be a big challenge.”
Hoffman said Arizona is already dependent on revenue from a sales tax rate that is moderately high to begin with. But compared to most states that actually have income taxes, Arizona’s rates are fairly low and not a hindrance to the economy, he said.
Rounds said businesses may prefer the benefits of the income tax revenue to the cuts that the candidates are proposing.
“Businesses need competitive taxes, but they also need stuff. They need roads. They need workers,” Rounds said.
Even if rising revenues offset the cost of tax cuts, Hoffman said that could come back to bite the state during the next economic downturn. If the state brings in extra revenue, he said lawmakers and the governor should use it to fund needed infrastructure instead. And he warned that while it only takes a simple majority in the Legislature to cut taxes, the two-thirds vote required to raise them makes increases politically unlikely.
“A tax cut is a permanent reduction,” Hoffman said. “An expenditure, those come and go.”
Kevin McCarthy, executive director of the Arizona Tax Research Association, agreed with Hoffman that income taxes aren’t a problem area for Arizona when it comes to trying to attract businesses. McCarthy said he didn’t think the dynamic effect of the tax cuts — the additional economic activity they could generate — would be sufficient to replace the lost revenue from the income taxes.
“There will be those that will make the argument that economic growth will cure all the sins, but aside from that kind of a dynamic forecast, we’re going to either cut spending or raise taxes in other areas to come up with those revenues,” McCarthy said.
Economist Alan Maguire was supportive of the proposals to eliminate income taxes, as long as it is done gradually. He said consumption taxes are far fairer, a sentiment echoed on the campaign trail by Bennett.
“It’s certainly a worthy goal to minimize income taxes, because frankly one could argue that they are the dumbest tax,” Maguire said. “I think you have to gradually shift toward consumption taxes. I think consumption taxes are the most economically neutral taxes.”
Maguire also said such a tax cut would encourage economic growth. But the tax revenue it would generate still wouldn’t be a dollar-for-dollar match, he said.
However, Maguire said that wouldn’t necessarily be a bad thing. He said government has gotten too big and suggested downsizing it while shifting some government programs and responsibilities over to local or federal governments. Maguire acknowledged that such a shift would, in some cases, lead to a reduction in government services.
“The size and scope of government has exploded over the last half century,” Maguire said. “Certainly there are things that could be returned either to the appropriate level of government or in some cases just back to the people to take care of themselves.”
Not all candidates agree
Fred DuVal, the Democratic nominee-in-waiting for the governor’s race, said the GOP candidates’ plans to eliminate income taxes are both bad policy and bad math.
“What schools are going to close and what prisons are going to close? That’s where all the money is,” DuVal said.
But criticism of the plans isn’t coming only from the Democratic side. Other Republican candidates are equally critical.
Former GoDaddy executive Christine Jones said her opponents who vow to eliminate income taxes aren’t being honest about what their plans will do. Jones said that, as a conservative, she loves the idea of an Arizona with no income taxes.
But the state will still have to find a way to replace that revenue, she said, and there’s no way to replace it without raising other taxes.
“I hear people talk about broad-based transaction tax. To me, that’s a euphemism for taxing food, taxing services,” Jones said. “I suppose the other alternative is to increase property taxes. … I don’t think the property tax increases or making Arizona the highest sales tax state in the nation are the way to go.”
Another GOP candidate, former California Congressman Frank Riggs, said he wants taxes to be as flat and fair as possible. But state government still has responsibilities, especially education, that must be funded as well.
“I think it is the height of irresponsibility for someone now to say that they believe that income taxes can be eliminated altogether. That begs the question, of course, of how high sales taxes and property taxes would go,” Riggs said.
Riggs said he would lower the corporate property tax rate if elected governor, but only in increments that could be offset with broader consumption taxes. Jones, too, said she wants to decrease taxes, but only if other revenue would replace the money Arizona would lose.
Even some potential beneficiaries of an Arizona without income taxes are skeptical. Farrell Quinlan, who runs the Arizona chapter of the National Federation of Independent Business, a small-business advocacy group, said reductions or elimination of the individual income tax rate, which most small businesses pay, would be beneficial.
But Quinlan said he was skeptical that the state would simply make do with less revenue. If income tax cuts must be offset with increased property taxes or an expanded sales tax base, small business owners will likely oppose it, he said.
“Small business owners have been very, very skeptical and, in fact, opposed to expanding the sales tax base,” Quinlan said. “The devil’s in the details. We’d have to see how the numbers play out.”
— Luige del Puerto contributed to this story.